Time Value of

Money
Topics

• The time value of money

• Importance of TVM in finance
• Present value and future value of single and lump sums
• Present value and future value of an uneven cash flow stream;
• Future value of perpetuity
 Decision Dilemma
You have three choices:
A. BDT 100,000 received today
B. BDT 120,000 received in 1 year
C. BDT 5000 per year indefinitely

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Decision Dilemma

[What basis do you make such an

economic comparison?]

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 • You have BDT 100,000 and two preferences.
• Putting into locker, take it after 2 years,
Decision • Invest in a 2-year Fixed Deposit @ 10%
Dilemma Interest rate
Concept

“The value of a given sum of money

to be received on a particular date is
more than the same sum of money to
be received on a later date”

BDT 100 (today) ≠ BDT 100 (One year

later)
 Time Value of Money
Money has a time value because it can earn more money over time (earning
power).

Money has a time value because its purchasing power changes over time
(inflation).

The opportunity cost of money is the interest rate that would be earned by
investing it.

Time value of money is measured in terms of interest rate.

Interest is the cost of money—a cost to the borrower and an earning to the lender

TIME allows one the opportunity to postpone consumption and earn INTEREST.
Definition
TVM is the notion that the
value of money changes with
the passage of time.
If money has a time value, does time
have a money value?
The Role of Time Value in Finance

• Most financial decisions involve costs & benefits that are spread out over
time.
• Time value of money allows comparison of cash flows from different
periods.

Question?
Would it be better for a company to invest $100,000 in a product that would
return a total of$200,000 in one year, or one that would return $500,000
after two years?
The Role of Time Value in Finance

• Most financial decisions involve costs & benefits that are spread
out over time.
• Time value of money allows comparison of cash flows from
different periods.

Answer!
It depends on the interest rate!

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 Applications of TVM

Capital Budgeting Securities Valuation Personal Finance

Basic Future value of
time a sum
value of
money
concepts Present value of
a sum
 Present Value and Future Value
PRESENT VALUE FUTURE VALUE
•Is the cash on hand today •Is the cash you will receive at a
•It is the amount you need today given future date
in to reach a future value •It is the amount you will receive in
•PRESENT VALUE TECHNIQUE uses the future from your cash on hand
•FUTURE VALUE TECHNIQUE uses
discounting to find its present compounding to find future value
value of each cash flow at time of each cash flow at the end of the
zero and then sums these values investment’s life and then sums
to find the investment’s value these values to find the
today investment’s future value
 Timelines
0 1 2 3
i
%
CF0 CF1 CF2 CF3

■Show the timing of cash flows.

■Tick marks occur at the end of
periods, so Time 0 is today; Time 1 is
the end of the first period (year,
month, etc.) or, the beginning of the
second period.
 Simple Interest
• Year 1: 5% of $100 = $5 + $100 = $105

• Year 2: 5% of $100 = $5 + $105 = $110

• Year 3: 5% of $100 = $5 + $110 = $115

• Year 4: 5% of $100 = $5 + $115 = $120

• Year 5: 5% of $100 = $5 + $120 = $125

With simple interest, you don’t earn interest

on interest.
 CompoundInterest
• Year 1: 5% of $100.00 = $5.00 + = $105.00
$100.00
• Year 2: 5% of $105.00 = $5.25 + = $110.25
$105.00
• Year 3: 5% of $110.25 = $5 .51+ = $115.76
$110.25
• Year 4: 5% of $115.76 = $5.79 + = $121.55
$115.76
•With
Yearcompound
5: interest,
5% of $121.55a depositor
= $6.08earns
+ =interest
$127.63
on$121.55
interest!
ILLUSTRATION
Computational Aids

• Use the Equations

• Use the Financial Tables

• Use Financial Calculators

• Use Spreadsheets
Computational Aids

Future value interest factor or present value interest

factor
Computational Aids
Time Value Terms
• PV0 = present value or beginning amount
= interest rate
• i/k/r

• FV = future value at end of “n” periods

n

= number of compounding periods

•n
= an annuity (series of equal payments or
•A
receipts)
Four Basic Models
BASIC PATTERNS OF CASH
FLOW
• SINGLE AMOUNT: a lump sum amount
either currently held or expected at some
future date
• ANNUITY: a level periodic stream of cash flow
• MIXED STREAM: a stream of unequal cash flows
that reflect no particular pattern
 Future Value
Example
Algebraically and Using FVIF Tables

You deposit $2,000 today at 6%

interest. How much will you have in 5
years?

$2,000 x (1.06)5 = $2,000 x FVIF6%,5

$2,000 x 1.3382 = $2,676.40
 Future Value Example
Using Excel

You deposit $2,000 today at 6%

interest. How much will you have in
5 years?
PV $ Excel Function
2,000
=FV (interest, periods, pmt, PV)
k 6.00%
n 5 =FV (.06, 5, nil, 2000)
FV? $2,676
 SELF TEST
Student Loan
You receive BDT 1,000,000 in August 2022. It collects interest at 5%
until graduation in August 2027. What amount do you owe upon
graduation?
 Compounding More Frequently than Annually

01 02 03
Compounding more As a result, the Furthermore, the
frequently than once effective interest rate effective rate of
a year results in a is greater than the interest will increase
higher effective nominal (annual) the more frequently
interest rate because interest rate. interest is
you are earning on compounded.
interest on interest
more frequently.
Compounding Interest More Frequently Than Annually

Interest is often compounded more frequently than once a year.

Savings institutions compound interest semi-annually, quarterly,
monthly, weekly, daily, or even continuously.

SEMIANNUAL COMPOUNDING of interest involves two compounding

periods within the year. Instead of the stated interest rate being paid
once a year, one- half of the stated interest rate is paid twice a year.

QUARTERLY COMPOUNDING of interest involves four compounding

periods within the year. One-fourth of the stated interest rate is
paid four times a year.
 Compounding More Frequently than Annually
• For example, what would be the difference in future value if I
deposit $100 for 5 years and earn 12% annual interest
compounded (a) annually, (b) semiannually, (c) quarterly, an (d)
monthly?
Annually: 100 x (1 + .12)5 = $176.23
Semiannually: 100 x (1 + .06)10 = $179.09
Quarterly: 100 x (1 + .03)20 = $180.61
Monthly: 100 x (1 + .01)60 = $181.67
Compounding More Frequently than
Annually
On Excel
Annually Semi-annually Quarterly Monthly
PV $ $ 100.00 $ $
100.00 100.00 100.00
i 12.0% 0.06 0.03 0.01
n 5 10 20 60
FV $176.23 $179.08 $180.61 $181.67
Present Value Example
Algebraically and Using PVIF Tables

How much must you deposit today in order

to have $2,000 in 5 years if you can earn
6% interest on your deposit?

$2,000 x [1/(1.06)5] = $2,000 x PVIF6%,5

$2,000 x 0.74758 = $1,494.52
 Present Value Example
Using Excel

How much must you deposit today in order

to have $2,000 in 5 years if you can earn
6% interest on your deposit?
FV $ Excel Function
2,000
=PV (interest, periods, pmt, FV)
k 6.00%
n 5 =PV (.06, 5, , 2000)
PV? $1,495
 Annuities
• Annuities are equally-spaced cash flows of equal size.

• Annuities can be either inflows or outflows.

• An ordinary (deferred) annuity has cash flows that occur

at the end of each period.

• An annuity due has cash flows that occur at the

beginning of each period.

• An annuity due will always be greater than an otherwise

equivalent ordinary annuity because interest will compound for
an additional period.
 What is the difference between
an ordinary annuity and an
annuity due?

Ordinary Annuity
0 1 2 3
i%

PMT PMT PMT

Annuity Due
0 1 2 3
i%

PMT PMT PMT

Annuities
 Present Value of a Perpetuity
• A perpetuity is a special kind of annuity.

• With a perpetuity, the periodic annuity or cash flow

stream continues forever.
PV = Annuity/i
• For example, how much would I have to deposit
today in order to withdraw $1,000 each year forever
if I can earn 8% on my deposit?

PV = $1,000/.08 = $12,500
 Future Value of a Mixed
Stream Using Tables
• A mixed stream of cash flows reflects no particular pattern
• Find the future value of the following mixed stream assuming a
required return of 8%.
Year Cashflow (1) No. of years FVIF Future Value [(1)x(3)]
earning int. (n) (3) (4)
Year Cash Flow
(2) F PV
9%,N
1 PVI 366.8
1 11,500 5-1 = 4 171.360 P15,640
400 0.9 0
2 14,000 2 800
5-2 = 3 0.8 421.260
$ 673.6 17,640
3 12,900 3 500
5-3 = 2 0.7 $
721.166 0
386.0 15,041
4 16,000 4 400
5-4 = 1 0.7 $
081.080 0
283.2 17,280
5 18,000 5 300
5-5 = 0 0.6 $
501.000 0
195.0 18,000
Fixed value of mixed$ stream 0 83,601.40
PV 904.6
 Future Value of a Mixed
Stream Using EXCEL
• Find the present value of the following mixed stream
assuming a required return of 8%.
A B
1 FUTURE VALUE OF A MIXED STREAM Excel Function
2 Interest rate, pct/year 8%
3 Year Year-End Cash Entry in Cell B9
Year Cash flow is =-
4 1Flow 400 1 11,500 FV(B2,A8,0,NPV
5 2 800 2 14,000
6 3 500 3
(B2,B4:B8)
12,900
7 4 400 4 16,000
8 5 300 5 18,000
9 Future Value 83,608
NPV
 Present Value of a Mixed Stream
Using Tables
• A mixed stream of cash flows reflects no particular
pattern
• Find the present value of the following mixed
stream assuming a required return of 9%.
Year Cash Flow PVIF9%,N PV
1 400 0.917 $
366.80
2 800 0.842 $
673.60
3 500 0.772 $
386.00
4 400 0.708 $
283.20
 Present Value of a Mixed Stream
Using EXCEL
• Find the present value of the following mixed
stream assuming a required return of 9%.
A B

1 PRESENT VALUE OF A MIXED STREAM OF

CASH FLOWS
Excel Function
2 Interest rate, pct/year 9%
Year Cash Entry in Cell B9 is
3 Year Year-End Cash Flow
Flow
1 400
4 1 P400 =NPV(B2,B4:B8)
2 800
5 2 P800
3 500
6 3 P500
7
4 400
4 P400
8 5 300
5 P300
9 NPVPresent Value P1,904.76
Nominal & Effective Rates
• The nominal interest rate is the stated or
contractual rate of interest charged by a lender or
promised by a borrower.
• The effective interest rate is the rate actually
paid or earned.
• In general, the effective rate > nominal rate
whenever compounding occurs more than once
per year
 Nominal & Effective Rates
• For example, what is the effective rate of interest on
your credit card if the nominal rate is 18% per year,
compounded monthly?

EAR = (1 + .18/12) 12 -1
EAR = 19.56%
Concept of Capital Budgeting
 Self-Test Questions

■What amount must you deposit today

in a three-year CD paying 4% interest
annually to provide you with $2249.73
at the end of the CD’s maturity?
■You invest $5000 today in a CD that
pays 5% interest annually. If you leave
your money invested for its entire
maturity period, you will have
$6077.53; What is the CD’s term to
maturity?
Capital Budgeting
• is a process to evaluate potential major projects
or investments.
• a company might assess a prospective project's
lifetime cash inflows and outflows
• to determine whether the potential returns that
would be generated meet a sufficient target
benchmark.
• The capital budgeting process is also known as
investment appraisal.
References

• Ross, S. A., Westerfield, R. W., Jordan, B. D., & Roberts, G. S., Air Pandes, J.,
Holloway, T., (2019). Fundamentals of corporate finance with Connect
(10th Cdn. ed.). Whitby, ON: McGraw-Hill Ryerson. Type: Textbook: ISBN:
9781260305869
• Brigham EF, Houston JF. Fundamentals of financial management. Cengage
Learning; 2021 Feb 4.
• Gitman, L. J., & Zutter, C. J. (2012). Principles of managerial finance. Edisi
ke-13.

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